In a recent blog post, Michael Pettis notes that while more invested capital per worker increases productivity in developing economies, economies have varying abilities to invest capital effectively. He labels this ability: “social capital constraints.” But he largely leaves the inner working of these constraints to the imagination of the reader.
My upcoming book, The Upside of Inequality: How Good Intentions Undermine the Middle Class, argues that properly trained talent and the economy’s capacity and willingness to take risk, namely equity, and not savings (e.g., risk-averse saving), now constrain growth and investment.
These two capacities interact with one another to accelerate growth. While equity bears risks that grow the economy, properly trained talent reduces investment risk by dreaming up better ideas (i.e., investments worth making and risks worth taking) and by overseeing the implementation of investment risk more effectively than lesser-skilled workers. Together they lead to increased and higher quality risk-taking.
The book identifies other factors that bear on the capacity of an economy to take risk and invest capital more effectiveness. Higher risk-adjusted payoffs for successful risk taking—from institutionalized expertise and lower tax rates for example—motivate increased risk-taking and training. At the margin, free market trial and error allocates resources more effectively than government planning. And of course, high quality rule of law—the efficiency of bankruptcy laws for example—also contributes to more effective risk-taking.